a. Government contracts may arise from negotiation or from formal
advertising. Contracts resulting from formal advertising must be either
firm-fixed-price (FFP) or fixed-price contracts with economic
adjustment and interim payments to the contractor, if any, are not
based on cost. Audits of contractor billing systems ordinarily do not
address policies and procedures for billings on commercial and
formally advertised government contracts.

b. Negotiated contracts are grouped into two broad categories:
fixed price contracts and cost reimbursement contracts. Fixed price
contracts may be firm-fixed-price, fixed-price with economic
adjustment or fixed price with incentive provisions. Fixed price
contracts may be eligible for progress payments, which are invoiced on
SF 1443, 'Contractor's Request for Progress Payment.' Progress
payments under fixed price contracts are limited to a predetermined
percentage (the 'progress payment percentage' specified in the
progress payment clause) of the total contract price and do not
include profit. Firm-fixed-price level of effort (FFP/LOE) contracts
are classified as fixed price, but the data submitted on billings under
such contracts closely resembles that submitted on time-and-materials
(T&M) contracts in that profit is included in the direct labor billing
rates.

c. Cost-type contracts include cost sharing, cost reimbursement
and cost plus fixed fee, award fee or incentive fee contracts. Interim
payment requests under cost-type contracts are submitted on SF 1034,
'Public Voucher for Purchases and Services Other Than Personal' and SF
1035, the continuation sheet. Fee may be billed with cost or may be
separately vouchered according to the contract terms, and includes a
percentage of the fee up to a predetermined limit. T&M and labor hours
contracts are also invoiced on SF 1034 and 1035, but profit is
included in the price of a labor hour. Contract types are discussed in
detail in FAR Part 16. Standard forms are illustrated in FAR Part 53.

2. Special Considerations -- Fixed Price Contracts

a. It is important to review the contract clauses affecting the
contractor's right to receive interim payments based on cost. A fixed
price contract may require first article approval (FAR 52.209-3 or -4)
before the contract is eligible for progress payments. Progress
payments must be liquidated against deliveries or other billable
milestones under the contract before any amounts other than progress
payments may be paid (FAR 52.232-16(b)). The progress payment and
liquidation rates are specified on the SF 1443 in items 6a and 6b
respectively.

b. The following example will illustrate the computation of
allowable interim payments under a fixed price contract which is not
in an overrun status. Assume that the contract requires the delivery
of 5 widgets over a two-year period at a unit price of $10,000; a
total contract value of $50,000 (5 x $10,000); that the liquidation
rate is 80% and the progress payment rate is 80%. The contractor
invoices the widgets as they are delivered. There is no standard form
for invoicing deliveries. If at the time the first article is
delivered the contractor has incurred $12,000 of eligible progress
payment costs and invoiced them on SF 1443s, it will have received
$9,600 (80% x $12,000) of unliquidated progress payments. The
government liquidates $8,000 (80% x $10,000) of this against the first
article, leaving an unliquidated balance of $1,600. The contractor
will bill the government and receive a payment of $2,000 ($10,000 --
$8,000).

c. The contractor is required to report an estimate to complete
on SF 1443, item 12b. The instructions to SF 1443 require that this
estimate shall be made not less frequently than every six months. FAR
32.503-6(g) requires that if the estimated costs are likely to exceed
the contract price, the contracting officer shall calculate a loss
ratio factor and adjust future progress payments to exclude the
element of loss. Audit steps for evaluation of the contractor's
estimate to complete and a matrix for computation of the loss ratio
factor appear in the standard audit program for progress payment
audits.

d. In addition to verifying that billed costs include only
amounts properly recorded and, where required, paid in accordance with
an approved cost accounting system, a billing system survey at a
location having significant progress payment billings must include a
review of the policies, procedures and controls for:

As with FFP contracts, progress payments under fixed price
incentive (FPI) contracts are made in accordance with FAR 52.232-16.
From an interim billing standpoint, FPI contracts differ from FFP only
in the profit computation. They must be audited prior to final payment
because the incentive profit is based on a comparison of the actual to
the target cost. In an FFP/LOE contract, the deliverable product is
the labor hour. Accordingly, such contracts rarely provide for
progress payments based on cost. In reviewing billing systems at
contractor locations having a significant volume of FFP/LOE work,
treat these contracts as if they were T&M.

4. Special Considerations -- Cost-type Contracts

a. Because the government assumes a higher percentage of risk
under cost reimbursement type contracts and because such contracts may
contain any number of special provisions affecting billings (ceiling
rates, unallowable or unallocable cost elements, key personnel, fee
billing and retention, etc.), the accounting and billing system
requirements for such contracts are more stringent than for FFP and
FPI contracts. Cost-type contracts permit inclusion in the periodic
billing of all allowable and allocable paid costs and certain recorded
but unpaid costs which do not exceed the contract ceiling or funding
limitation, reduced by the contractor's percentage in the case of a
cost-sharing contract; and such costs are provisionally reimbursed in
full, subject to subsequent audit. Fee billings may be vouchered with
cost or separately, depending on the contract terms which frequently
provide for a fee retention pending contract completion and closeout.

b. In addition to verifying that billed costs include only
amounts properly recorded and, where required, paid in accordance with
an approved cost accounting system, a billing system survey at a
location having significant cost-reimbursable work must include a
review of the policies, procedures and controls for:

(6) Including Form 1 suspensions on subsequent vouchers as an
offset to cumulative billed cost.

5. Special Considerations -- T&M and Labor Hours Contracts

a. T&M and labor hours contract costs are vouchered on SFs 1034
and 1035. They are a mixed contract type, since labor is billed at
price and other direct costs (ODCs) are billed at cost. T&M and labor
hours contracts provide for billing direct labor hours at
predetermined category rates which include all applicable burden and
profit, and bill ODCs (and direct materials on T&M contracts) at cost
plus applicable burden. These contracts permit billings up to a stated
percentage of the contract value, and may or may not require that each
invoice be adjusted to the limitation percentage.

b. T&M and labor hours contracts contain an inherent risk so high
that they may be used only after the contracting officer executes a
determination that no other contract type is suitable. Nevertheless,
at many locations this least favored contract type constitutes a
substantial percentage of the workload. A billing system audit is not
the best place to identify and correct control weaknesses which arise
under this contract type. Refer to 6-204.

c. It is quite common for the contract to specify labor
categories which do not coincide with the contractor's established
labor classifications. Ideally, the contract itself will specify the
required skills and experience for each billable labor category. When
this is not the case, the contractor's proposed classifications
determine the propriety of employee classifications to contract
categories by operation of the Order of Precedence clause (FAR
52.215-8). The contractor's labor distribution system should input
incurred labor hours by contract category to the billing system, and
the controls preventing misclassification of employees should be
reviewed as a part of the labor controls. If these controls do not
exist, or have not been evaluated, they must be evaluated as a part of
the billing system audit.

d. In addition to review of the controls affecting
cost-reimbursable billings, review of a billing system which processes
a significant volume of T&M, labor hour, or FFP/LOE contracts must
verify that controls are in place which assure: that billings include
only actual labor hours per the labor distribution; that each billed
hour is assigned to its proper category; and that categories are
billed at the correct contractual rate.

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